Marshallian Industrial Districts and the Rise of the Internet

Recently I attended a Conference for the 40th Anniversary of the Cambridge Journal of Economics where a talk was given on “Industrial Districts, Organisation & Policy”. This article is a summary of some of the discussion from this talk as well as my further thoughts on extending Marshallian Industrial Districts to incorporate the internet.

What is a Marshallian Industrial District?
A Marshallian Industrial District is normally considered a clustering of firms in a similar industry operating from a certain geographic area. Being close to many other firms in the same industry allows a number of benefits, sometimes called benefits of agglomeration or Marshallian atmospheric externalities. These include:

Marshall himself saw the benefits of small companies being the division of labour and specialisation which led to more efficient use of resources. Smaller companies producing only one good will be able to gain specialist experience and knowledge in producing such a good, which ought to lead to an increase in output.

Clustering of firms in a geographic area means knowledge should flow between firms more easily through the workforce, in discussions and seminars between managers in coffee-houses or more formal institutions along with other informal channels. It may seem strange, in a neoclassical framework, that competing firms would discuss and share ideas and techniques but we can imagine this happening as gossip spreads through the geographic cluster.

Customer recognition: clustering means that consumers know where to go if they want a particular good, and so can reduce the cost and effort associated with having to advertise and may increase demand. For example, if a British individual wanted to see a musical in London, then they know that they would need to go to the West End as this is where the clustering of theatres are; this means that such theatres don’t need to focus their efforts on telling consumers where to go to see their plays, but only in convincing them to see THEIR play, rather than that of their neighbour.

It should be easier to hire a workforce with the correct skills, as labour with the right skills would know where to congregate for a job, hence reducing asymmetries of information; hopefully reducing the length of unemployment for such workers. Furthermore, the sharing of workforce between firms increases expertise and helps the flow of information in a clustering.

Infrastructure and auxiliary firms will be established in the clustering, reducing costs: a clustering of firms in one geographic area makes it more cost efficient (either for the private community, or for the public community responsible for investment of tax) to build infrastructure required for the particular industry. This has the effect of reducing costs for firms and increasing productivity. In addition, auxiliary firms (firms which provide inputs to firms further down the supply chain) will set-up near the firms they supply, a clustering of one industry will lead to the development of auxiliary firms in this area, thus reducing costs and making it easier for firms to source inputs.

Ottati points out that credit is easier to obtain for firms in the MID, perhaps this is because they have better access to investors with the knowledge and willingness to invest in that given industry.

The ability to accept large orders without fear of being able to deliver, as these can be passed on to other nearby firms. Consider a textile-producer who has been given an order for X amount of clothes, where X is greater than the amount they can produce themselves. Rather than have to engage in time-costly and expensive investment to be able to fulfill this order (investment which may not be needed long-term), or worse still, have to refuse the order, the firm can simply purchase the remainder of X they haven’t been able to produce from other nearby firms. Without a clustering, this may be more difficult to do, resulting in the firm being forced to refuse the order.

Kaldor stressed the importance of “joint production between small specialised firms which involves frequent transfer of an unfinished product between numerous specialised firms” which is obviously an important factor in an MID.

Finally, as Konzelmann, Wilkinson and Fovargue-Davies point out that “firms concentrate their initiative and inventiveness on what they do best and establish an environment that improves the overall competitiveness of the locality”.

An MID is thus typically charaterised as a geographic area which has a high degree of vertical and/or horizontal specialisation, and a reliance on the market mechanism to provide exchange. In a separate article, I write about MIDs in the Industrial Revolution, and how competition was strong and explains why the UK didn’t have large firms, like in the USA.

As well as the benefits to MID we explored above, there can also be some downsides. Firstly, small firms may be more susceptible to bankruptcy in the event of an economic shock which reduces aggregate demand in the short run and hence lead to hysteresis effects such as permanently lower GDP. Larger firms may have more retained earnings and the ability to survive through cross-subsidisation (taking profits from certain sectors to remain present in temporarily loss-making sectors). Secondly, we would only expect an industrial district to form if there were limits to economies of scale: if a firm had increasing returns to scale (it could produce a good more cheaply by producing lots of it) then it wouldn’t stay small but would turn into a large firm.Thirdly, there can be congestion effects from a large concentration of firms in one area: if these firms are industrial then traffic may be a serious issue which starts to increase costs and reduce benefits from agglomeration; air and noise pollution may increase reducing the desirability to live and work in such areas; increasing demand for labour and land may lead to higher prices (rent/wages) offsetting the benefits provided by the MID.How has the internet affected the development of Marshallian Industrial Districts?The internet has had a major effect on how we live our lives and also in how the economy is shaped. Along with other technological developments and the phenomenon of outsourcing – explored below – it has arguably been responsible for the decline in the Marshallian Industrial Districts. This is because the internet and the rise of technology has led to outsourcing of industry to cheaper industrialising countries, and permitted the expansion of companies into conglomerates which can produce goods internally, rather than relying on a multitude of other companies for input goods.

Of course, it can be counter-argued that outsourcing has led to a split in production processes which means more companies produce inputs which go into the production of a final good, such a question needs to be considered empirically, which is beyond the scope of this article.

More fundamentally it could be counter-argued that one of the most important MID in existence today is that of Silicon Valley, itself founded on the internet and technological developments. We consider Silicon Valley as an MID due to it enjoying most of the benefits which we examined above, namely the sharing of ideas, the availability to source skilled labour and the necessary infrastructure (in this case fibre-optics and good transport links to aid the commute of the many workers).

The internet, and other developments in transport and technology have meant that geography is less of an issue nowadays. At first this may seem to proliferate the decline of the MIDs, but we argue that contrary to this it has actually enhanced them: a company can still benefit from Marshallian atmospheric externalities without having the congestion costs associated with being confined to a geographic MID. The internet means that ideas and techniques can be transmitted to people across the world, no matter where they are, proliferating externalities typically associated with agglomeration, without the need to physically be close to each other. It may be seen that cottage industry rises, with people producing goods and services from their home, as they learn how to do so from online websites, without the need to be sourced near competitor firms. In addition, online forums allow ideas and questions to be posed and answered; again aiding small firms to continue production and compete with larger firms.

In a private discussion with Konzelmann and Fovargue-Davies, they argue that the most important aspect of the internet is the opportunities it has opened up for selling. The internet means that small firms are able to advertised and sell their goods online to anybody anywhere in the world, thus increasing demand and making it easier for firms to sell their products without having to invest heavily in a sales division (something which we would expect larger firms to be better at). Furthermore, making it easy to sell via the internet means that it is also easier to source input goods, and thus allows firms to be more reliant on the market for their input goods, rather than having to expand horizontally (thereby not benefiting from Marshallian externalities) in order to guarantee the supply chain.

Are Industrial Districts still important?

There are many modern developments which may inhibit the workings of a MID, perhaps the most important is the rise of the internet, discussed above. However there are other factors, which we turn to now.

We begin by proposing that economies of scale have increased over the last 100 years, since Marshall first proposed the notion of industrial districts. Modern technology, and mass production of goods in state-of-the-art factories means that we see increasing returns to scale (IRS) for most goods. This might help explain why we see ever-growing companies and oligopolistic markets (i.e. markets occupied by only a small number of large firms). Whilst this may be the case – and a condition of IRS makes the establishment of MIDs more difficult – it isn’t universally true for all goods. If we consider certain goods such as high-quality high-valued goods – of which only a few are made, either because of low demand, or the Veblenian* nature of the good – then these will likely be made by small companies who benefit from specialisation and Marshallian atmospheric externalities.

Ottati mentions the decline of banking as a serious issue for the sustainability of MIDs: with ever growing banks which focus only on large clients, and don’t attempt to engage with their clients, focusing on large cities (becoming London-centric) then there will be a fall in investment for upstarting small firms which could form into a Marshallian district. Consider Silicon Valley: without investors prepared to risk their money in such risky ventures such an MID wouldn’t have developed, this is ever-increasingly likely as the dominance of banks increases.

The ability for firms to propel themselves further up the supply chain, producing high-quality goods, and focusing on technology and R+D is vital for the prosperity of MIDs and the ability to do this s vital for securing the continuance of Marshallian Industrial Districts. In addition, the internet has allowed MIDs to flourish without the geographic constraints typically felt, meaning that the benefits of MIDs can continue without so many of the costs.

*A Veblen good experiences a conspicuous consumption effect, whereby more is sold at a higher price. Consider the example of a Ferrari car or an expensive watch, these goods are expensive because the people who wish to purchase them wish to signal to other people their wealth and influence, and do this by purchasing goods which are expensive just for the sake of being expensive (although, it is still the case that the quality is very high, but not proportional to the expense of the good).